Over the last 3 to 4 years we have noticed an increase in the number of cases where there is an overdrawn director’s loan account or dividends have been drawn illegally.

Now it is understandable that directors wish to be remunerated in the most tax effective way and commonly they will be advised to pay a minimal salary and then draw the balance as dividends. This advice is absolutely fine whilst the Company is making profits and has distributable reserves.

However if the business hits harder times, the directors need to reconsider the position. We have seen a number of cases where because the Company has no reserves, drawings have been posted to the director’s loan account which then becomes overdrawn.

We have also seen a number of cases where dividends have been drawn even though the business has no reserves, and are therefore are illegal.

So what could happen if the Company fails?

  • The Insolvency Practitioner (IP) will see the overdrawn director’s loan account as a debt which should be collected for the benefit of creditors. The Directors will be unable to claim a dividend or bonus to offset this and, as often as they will have no contract of employment, neither can they claim the sums to be a salary either.
  • This could lead to the personal insolvency of the director.
  • Any dividend which is drawn, if demonstrated that reserves were not available at the time can be overturned by the courts and repaid.
  • HM Revenue & Customs (HMRC) is paying very close attention to ensure that director’s loan accounts are repaid. If they are not repaid or are only partially repaid they are pursuing directors personally, claiming these sums as untaxed income.
  • The implementation of RTI makes it very difficult for directors to ‘backdate’ bonuses or salary. These could be seen as either as preferences or misfeasance and therefore could be overturned.

Our advice to directors who appreciate that the Company is on the tipping point is to consider with their professional advisers how they are going remunerate themselves moving forward. It is also important to document any decisions made at the time.